05/05/2012 (The Star) - Is the value and worth of an oil palm plantation in a structural uptrend?

Agricultural properties are seldom featured in mainstream discussions on the property market in Malaysia. Yet we are a global producer of palm oil and palm oil products and have almost a monopoly of the production of this agricultural produce, together with Indonesia. About 90% of the planted area of this “golden crop” is from Indonesia and Malaysia.

The palm oil industry is part of the global oils and fats market and it is important to view the industry in this light. Other significant oils and fats (there are 17) include soyabean oil, rapeseed oil, and sunflower oil. Prices and demand for these four oils are highly correlated.

At the heart of the palm oil industry is the oil palm plantation or estate, usually divided into 5,000-acre “divisions” for management efficiency. Unlike soybean and sunflower which are cash crops, the oil palm is a perennial crop and once planted it has an economic life of about 25 years.

The value of an oil palm plantation depends on many macro and micro factors. These include the price of crude palm oil and palm kernel oil, the yield profiles from each of the planted fields and this in turn depends on type of clones used, rainfall, palm densities, soil, terrain and management. Other important constituents of value are the costs of production, planting to maturity and replanting.

Of these factors, the most sensitive and which valuers place much emphasis on is the price of palm oil in the international market. For agricultural properties, and so for oil palm plantations, the value of a plantation does not gyrate with the market price of the final product. Value moves gradually with the long-term sustainable price and for a long time in the past, that price hovered around RM1,500 per tonne and at this price, a prime oil palm plantation (one which is well and fully planted and well managed) could fetch between RM12,000 and RM15,000 per acre, reflecting also a market derived discount rate of 14% to 15%.

Since 2006, there has been a significant change in the market. The prices of palm oil and other leading oils and fats have taken off towards a higher stratum, departing from the long-term historical band. Is that due to the global commodities boom tied to the global financial crisis or a sustainable re-rating of the market because more of humanity is becoming mainstream consumers? If a global commodities boom, then how long will it last?

With this change, what is the sustainable price for ascertaining the market value of a plantation? So far there are only a few market sale indicators, and no clear market sale of a well and fully planted and well-managed plantation that can act as a good guide to value based on the new price parameters. However, from the use of the same income approach model as used before (and with small needed adjustments for updating to current costs), and if the long-term sustainable price were to be pitched at RM2,500 per tonne (notwithstanding the current prevailing price of slightly above RM3,300 per tonne) then the value for a similar prime plantation as contemplated earlier in this article ought to be move toward RM20,000 per acre. A further adjustment to the model to reflect a better outlook by lowering the market derived discount rate to 12% and a value of slightly above RM20,000 per acre becomes apparent.

But the nagging question is whether this new price level is indeed a structural shift to new sustainable level for the long term, or will the price settle down to a lower level post a commodities boom.

Be that as it may, market participants are asking for prices well in excess of the RM20,000-per-acre level for plantations, and that are not necessarily well and fully planted and well managed. This value is usually applicable at the divisional level of a plantation but if the plantation is much larger, a discount for size is applicable.

Lower per unit values are also applicable if the plantation in question is not well and fully planted and well managed or has some inherent disadvantaging factors like poorer location, soil or terrain. Values of smallholdings on the other hand usually have higher per unit values than plantation land, being smaller entities with a larger market when it comes to sales and purchases.

A market worth of a plantation differs from a market value in that it is viewed not from the market as such but from a purely investment point of view. Hence the discount rate is not market derived but derived from the investment market, much like how shares are valued in opposition to the prevailing share price. Currently the market worth is higher than the market value and this is also a signal that market participants usually take into account before making investments in oil palm plantation or they ought to. Small wonder then that the asking prices are much higher than the past, established comparative values.